Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **x** | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31,2009**

 

**OR**

 
| **o** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom               to               **

 

**Commission File Number: 0-24081**

 

**EVOLVING SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **84-1010843**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or  organization) |       | (I.R.S. Employer Identification No.) |
| ** **                                                      | ** ** | ** **                           |
| **9777 Pyramid Court, Suite 100 Englewood,  Colorado**     | ** ** | **80112**                            |
| (Address of principal executive offices)                        |       | (Zip Code)                           |

 
| **(303) 802-1000**                                   |
|-----------------------------------------------------------|
| (Registrant’s telephone number, including area code) |

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes xNo o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every

Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the

preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes   ̈ No  ̈

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer, or asmaller reporting company.  Seedefinition of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer  ̈           |   | Accelerated  filer  ̈    |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer  ̈             |   | Smaller  reporting company x |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes  ̈  No x

 

As of May 4,2009 there were 19,553,103 shares outstanding of Registrant’s Common Stock (parvalue $0.001 per share).

 

 

 

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**EVOLVING SYSTEMS, INC.**

**Quarterly Report on Form 10-Q**

**March 31, 2009**

**Table of Contents**

 
| **PART I  – FINANCIAL INFORMATION** |
|-----------------------------------------------|
| Item 1                                        | Financial Statements |
|                                          | Condensed Consolidated Balance  Sheets as of March 31, 2009 and December 31, 2008 (Unaudited) |
|                                          | Condensed Consolidated  Statements of Operations for the Three Months Ended March 31, 2009 and  2008 (Unaudited) |
|                                          | Condensed  Consolidated Statements of Changes In  Stockholders’ Equity and Comprehensive Income (Loss) for the Three Months  Ended March 31, 2009 (Unaudited) |
|                                          | Condensed Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2009 and  2008 (Unaudited) |
|                                          | Notes to  Unaudited Condensed Consolidated Financial Statements |
| Item 2                                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item 3                                        | Quantitative  and Qualitative Disclosures About Market Risk |
| Item 4                                        | Controls and  Procedures |
| ** **                                    | ** ** |
| **PART II – OTHER  INFORMATION**    |
| Item 1                                        | Legal Proceedings |
| Item 1A                                       | Risk Factors |
| Item 2                                        | Unregistered  Sales of Equity Securities and Use of Proceeds |
| Item 3                                        | Defaults  upon Senior Securities |
| Item 4                                        | Submission  of Matters to a Vote of Security Holders |
| Item 5                                        | Other Information |
| Item 6                                        | Exhibits |
|                                          |   |
| Signature                                     |   |

 

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**PART I– FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(in thousands except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                                                  |       |               |       |                  |       |
| Current assets:                                                                                                                                                                             |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                   |       | $                  | 7,993      |                  | $          | 5,783 |   |
| Contract  receivables, net of allowance for doubtful accounts of $534 at March 31,  2009 and December 31, 2008                                                                    |       | 6,094              |       | 11,484                |       |
| Unbilled  work-in-progress                                                                                                                                                                  |       | 2,185              |       | 1,910                 |       |
| Deferred income  taxes                                                                                                                                                                      |       | 5                  |       | 5                     |       |
| Prepaid and  other current assets                                                                                                                                                           |       | 1,261              |       | 1,304                 |       |
| Total current  assets                                                                                                                                                                       |       | 17,538             |       | 20,486                |       |
| Property and  equipment, net                                                                                                                                                                |       | 1,321              |       | 1,277                 |       |
| Amortizable  intangible assets, net                                                                                                                                                         |       | 2,162              |       | 2,374                 |       |
| Goodwill                                                                                                                                                                                    |       | 20,541             |       | 20,811                |       |
| Long-term  restricted cash                                                                                                                                                                  |       | 100                |       | 100                   |       |
| Long-term  deferred income taxes                                                                                                                                                            |       | 53                 |       | 56                    |       |
| Other long-term  assets                                                                                                                                                                     |       | 212                |       | 307                   |       |
| Total assets                                                                                                                                                                                |       | $                  | 41,927     |                  | $          | 45,411 |   |
|                                                                                                                                                                                        |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                               |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                       |       |               |       |                  |       |
| Current portion  of capital lease obligations                                                                                                                                               |       | $                  | 22         |                  | $          | 21 |   |
| Current portion  of long-term debt                                                                                                                                                          |       | 1,833              |       | 2,000                 |       |
| Accounts payable  and accrued liabilities                                                                                                                                                   |       | 4,339              |       | 5,198                 |       |
| Deferred income  taxes                                                                                                                                                                      |       | 20                 |       | 20                    |       |
| Unearned revenue                                                                                                                                                                            |       | 10,462             |       | 11,445                |       |
| Total current  liabilities                                                                                                                                                                  |       | 16,676             |       | 18,684                |       |
| Long-term  liabilities:                                                                                                                                                                     |       |               |       |                  |       |
| Capital lease  obligations, net of current portion                                                                                                                                          |       | 53                 |       | 59                    |       |
| Other long-term  obligations                                                                                                                                                                |       | 213                |       | 1,402                 |       |
| Long-term debt,  net of current portion                                                                                                                                                     |       | 3,918              |       | 4,883                 |       |
| Deferred income  taxes                                                                                                                                                                      |       | 403                |       | 441                   |       |
| Total  liabilities                                                                                                                                                                          |       | 21,263             |       | 25,469                |       |
|                                                                                                                                                                                        |       |               |       |                  |       |
| Commitments and  contingencies (Note 10)                                                                                                                                                    |       |               |       |                  |       |
|                                                                                                                                                                                        |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                 |       |               |       |                  |       |
| Preferred stock,  $0.001 par value; 2,000,000 shares authorized; no shares of Series B issued  and outstanding as of March 31, 2009 and December 31, 2008,  respectively          |       | —             |       | —                |       |
| Common stock,  $0.001 par value; 40,000,000 shares authorized; 19,529,415 and 19,506,786 shares  issued and outstanding as of March 31, 2009 and December 31, 2008,  respectively |       | 20                 |       | 20                    |       |
| Additional  paid-in capital                                                                                                                                                                 |       | 82,030             |       | 81,814                |       |
| Accumulated  other comprehensive loss                                                                                                                                                       |       | (5,733             | )          | (5,270                | )          |
| Accumulated  deficit                                                                                                                                                                        |       | (55,653            | )          | (56,622               | )          |
| Total  stockholders’ equity                                                                                                                                                            |       | 20,664             |       | 19,942                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                            |       | $                  | 41,927     |                  | $          | 45,411 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands except per share data)**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| License fees and  services                                                   |       | $                                     | 4,745      |   | $ | 4,832 |   |
| Customer support                                                             |       | 4,098                                 |       | 4,295 |   |
| Total revenue                                                                |       | 8,843                                 |       | 9,127 |   |
|                                                                         |       |                                  |       |   |   |
| **COSTS  OF REVENUE AND OPERATING EXPENSES**                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Costs of license  fees and services, excluding depreciation and amortization |       | 1,677                                 |       | 2,224 |   |
| Costs of  customer support, excluding depreciation and amortization          |       | 1,433                                 |       | 1,493 |   |
| Sales and  marketing                                                         |       | 1,887                                 |       | 2,187 |   |
| General and  administrative                                                  |       | 1,433                                 |       | 1,425 |   |
| Product  development                                                         |       | 695                                   |       | 1,068 |   |
| Depreciation                                                                 |       | 156                                   |       | 230 |   |
| Amortization                                                                 |       | 171                                   |       | 380 |   |
| Total costs of  revenue and operating expenses                               |       | 7,452                                 |       | 9,007 |   |
|                                                                         |       |                                  |       |   |   |
| Income from  operations                                                      |       | 1,391                                 |       | 120 |   |
|                                                                         |       |                                  |       |   |   |
| Other income  (expense)                                                      |       |                                  |       |   |   |
| Interest income                                                              |       | 5                                     |       | 78 |   |
| Interest expense                                                             |       | (257                                  | )          | (336 | ) |
| Loss on  extinguishment of debt                                              |       | —                                |       | (290 | ) |
| Foreign currency  exchange gain (loss)                                       |       | (165                                  | )          | 110 |   |
| Other expense,  net                                                          |       | (417                                  | )          | (438 | ) |
|                                                                         |       |                                  |       |   |   |
| Income (loss)  before income taxes                                           |       | 974                                   |       | (318 | ) |
|                                                                         |       |                                  |       |   |   |
| Income tax  expense (benefit)                                                |       | 5                                     |       | (74 | ) |
|                                                                         |       |                                  |       |   |   |
| Net income  (loss)                                                           |       | $                                     | 969        |   | $ | (244 | ) |
|                                                                         |       |                                  |       |   |   |
| Basic income  (loss) per common and preferred share                          |       | $                                     | 0.05       |   | $ | (0.01 | ) |
| ** **                                                                   | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Diluted income  (loss) per common and preferred share                        |       | $                                     | 0.05       |   | $ | (0.01 | ) |
|                                                                         |       |                                  |       |   |   |
| Weighted average  basic shares outstanding                                   |       | 19,529                                |       | 19,362 |   |
| Weighted average  diluted shares outstanding                                 |       | 19,795                                |       | 19,362 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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** **

**EVOLVINGSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)**

**(inthousands, except share data)**

**(unaudited)**

 
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-------------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**         | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated**   | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income (Loss)** | ** ** | **(Deficit)**          | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2008**                            | ** ** | **19,506,786**   | ** ** | **$**       | **20**     | ** **        | **$**      | **81,814**        | ** ** | **$**                  | **(5,270** | **)**      | **$**      | **(56,622** | **)** | **$** | **19,942** | ** ** |
| Common Stock  issued pursuant to the Employee Stock Purchase Plan |       | 22,629           |       | —      |       | 15                |       | —            |       | —                 |       | 15         |       |
| Stock-based compensation  expense                                 |       | —           |       | —      |       | 201               |       | —            |       | —                 |       | 201        |       |
| Comprehensive  income (loss):                                     |       |             |       |        |       |              |       |              |       |                   |       |       |       |
| Net income                                                        |       | —           |       | —      |       | —            |       | —            |       | 969                    |       |       |       |
| Foreign currency  translation adjustment                          |       | —           |       | —      |       | —            |       | (463              | )          | —                 |       |       |       |
| Comprehensive  loss                                               |       |             |       |        |       |              |       |              |       |                   |       | 506        |       |
| **Balance  at March 31, 2009**                               | ** ** | **19,529,415**   | ** ** | **$**       | **20**     | ** **        | **$**      | **82,030**        | ** ** | **$**                  | **(5,733** | **)**      | **$**      | **(55,653** | **)** | **$** | **20,664** | ** ** |

** **

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**EVOLVING SYSTEMS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

** **
| ** **                                                                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                |       |                                  |       |   |   |
| Net income  (loss)                                                                        |       | $                                     | 969        |   | $ | (244 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation                                                                              |       | 156                                   |       | 230 |   |
| Amortization of  intangible assets                                                        |       | 171                                   |       | 380 |   |
| Amortization of  debt issuance costs                                                      |       | 33                                    |       | 41 |   |
| Stock based  compensation                                                                 |       | 201                                   |       | 228 |   |
| Loss on  extinguishment of debt                                                           |       | —                                |       | 290 |   |
| Unrealized  foreign currency transaction (gains) and losses, net                          |       | 165                                   |       | (110 | ) |
| Benefit from  foreign deferred income taxes                                               |       | (29                                   | )          | (74 | ) |
| Change in  operating assets and liabilities:                                              |       |                                  |       |   |   |
| Contract  receivables                                                                     |       | 5,126                                 |       | 4,653 |   |
| Unbilled work-in-progress                                                                 |       | (309                                  | )          | (634 | ) |
| Prepaid and  other assets                                                                 |       | 31                                    |       | (330 | ) |
| Accounts payable  and accrued liabilities                                                 |       | (811                                  | )          | (253 | ) |
| Unearned revenue                                                                          |       | (919                                  | )          | (871 | ) |
| Other long-term  obligations                                                              |       | (1,190                                | )          | (603 | ) |
| Net cash  provided by operating activities                                                |       | 3,594                                 |       | 2,703 |   |
|                                                                                      |       |                                  |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                                  |       |   |   |
| Purchase of  property and equipment                                                       |       | (208                                  | )          | (314 | ) |
| Net cash used in  investing activities                                                    |       | (208                                  | )          | (314 | ) |
|                                                                                      |       |                                  |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                                  |       |   |   |
| Capital lease  payments                                                                   |       | (5                                    | )          | (4 | ) |
| Principal  payments on long-term debt                                                     |       | (1,131                                | )          | (6,798 | ) |
| Proceeds from  issuance of long-term debt                                                 |       | —                                |       | 4,000 |   |
| Payments for  debt issuance costs                                                         |       | —                                |       | (129 | ) |
| Proceeds from  the issuance of stock                                                      |       | 15                                    |       | 16 |   |
| Net cash used in  financing activities                                                    |       | (1,121                                | )          | (2,915 | ) |
|                                                                                      |       |                                  |       |   |   |
| Effect of  exchange rate changes on cash                                                  |       | (55                                   | )          | (8 | ) |
|                                                                                      |       |                                  |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 2,210                                 |       | (534 | ) |
| Cash and cash  equivalents at beginning of year                                           |       | 5,783                                 |       | 7,271 |   |
| Cash and cash  equivalents at end of year                                                 |       | $                                     | 7,993      |   | $ | 6,737 |   |
|                                                                                      |       |                                  |       |   |   |
| Supplemental  disclosure of other cash and non-cash financing transactions:               |       |                                  |       |   |   |
| Interest paid                                                                             |       | $                                     | 1,417      |   | $ | 928 |   |
| Income taxes  paid                                                                        |       | 258                                   |       | 75 |   |
| Conversion of  preferred stock into common stock                                          |       | $                                     | —     |   | $ | 5,587 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**EVOLVINGSYSTEMS, INC.**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – BASIS OF PRESENTATION**

 

**Organization-**We are a provider of software solutions and servicesto the wireless, wireline and IP carrier markets. We maintain long-standingrelationships with many of the largest wireline, wireless and cable companiesworldwide. Our customers rely on us to develop, deploy, enhance, maintain andintegrate complex, highly reliable software solutions for a range of OperationsSupport Systems (“OSS”).  We offersoftware products and solutions in four core areas:  service activation solutions used toactivate complex bundles of voice, video and data services for traditional andnext generation wireless and wireline networks; numbering solutions that enable carriers to comply withgovernment-mandated requirements regarding number portability as well asproviding phone number management and assignment capabilities; SIM cardactivation solutions used to dynamically allocate and assign resources to awireless device when it is first used, and mediation solutionssupporting data collection for both service assurance and billing applications.

 

**Interim Consolidated Financial Statements** – Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) and in conformity with the instructions to Form 10-Qand Article 10 of Regulation S-X and the related rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and notedisclosures normally included in financial statements prepared in accordancewith GAAP have been condensed or omitted pursuant to such rules andregulations. However, we believe that the disclosures included in thesefinancial statements are adequate to make the information presented notmisleading. The unaudited condensed consolidated financial statements includedin this document have been prepared on the same basis as the annualconsolidated financial statements, and in our opinion, reflect all adjustments,which include normal recurring adjustments necessary for a fair presentation inaccordance with GAAP and SEC regulations for interim financial statements. Theresults for the three months ended March 31, 2009 are not necessarilyindicative of the results that we will have for any subsequent period.  These unaudited condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and the notes to those statements for theyear ended December 31, 2008 included in our Annual Report on Form 10-K.

 

**Use of Estimates -**The preparation of financialstatements in conformity with accounting principles generally accepted in theU.S. requires us to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities, at the date of the financial statements, as well as the reportedamounts of revenue and expenses during the reporting period. We made estimateswith respect to revenue recognition for estimated hours to complete projectsaccounted for using the percentage-of-completion method, allowance for doubtfulaccounts, income tax valuation allowance, fair values of long-lived assets,valuation of intangible assets and goodwill, useful lives for property,equipment and intangible assets, business combinations, capitalization ofinternal software development costs and fair value of stock-based compensationamounts.  Actual results could differfrom these estimates.

 

**Foreign Currency Translation -**Our functional currency isthe U.S. dollar.  The functional currencyof our foreign operations is the respective local currency for each foreignsubsidiary.  Assets and liabilities offoreign operations denominated in local currencies are translated at the spotrate in effect at the applicable reporting date.  Our consolidated statements of operations aretranslated at the weighted average rate of exchange during the applicableperiod.  The resulting unrealizedcumulative translation adjustment, net of applicable income taxes, is recordedas a component of accumulated other comprehensive income (loss) instockholders’ equity.  Realized andunrealized transaction gains and losses generated by transactions denominatedin a currency different from the functional currency of the applicable entityare recorded in other income (loss) in the period in which they occur.

 

**Principles of Consolidation -**The consolidated financialstatements include the accounts of Evolving Systems and subsidiaries, all ofwhich are wholly owned.  All significantintercompany transactions and balances have been eliminated in consolidation.

 

**Goodwill -**Goodwill is the excess of acquisition cost ofan acquired entity over the fair value of the identifiable net assetsacquired.  Goodwill is not amortized, buttested for impairment annually or whenever indicators of impairment exist. Theseindicators may include a significant change in the business climate, legalfactors, operating performance indicators, competition, sale or disposition ofa significant portion of the business or other factors. For purposes of thegoodwill evaluation, we compare the fair value of each of our reporting unitsto its respective carrying amount. If the carrying value of a reporting unitwere to exceed its fair value, we would then compare the fair value of thereporting unit’s goodwill to its carrying amount, and any excess of thecarrying amount over the fair value would be charged to operations as animpairment loss.

 

**Intangible Assets -**Amortizable intangibleassets consist primarily of purchased software and licenses, customer contractsand relationships, trademarks and tradenames, and business partnershipsacquired in conjunction with our purchases of CMS Communications, Inc.(“CMS”), Telecom Software Enterprises, LLC (“TSE”) and Tertio Telecoms Ltd.(“Evolving Systems U.K”).  These definitelife assets are amortized using the straight-line method over their estimatedlives.

 

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We assess the impairment of identifiable intangibles if events orchanges in circumstances indicate that the carrying value of the asset may notbe recoverable. Factors that we consider significant which could trigger animpairment analysis include the following:

 

·                  Significant under-performance relative tohistorical or projected future operating results;

 

·                  Significant changes in the manner of use ofthe acquired assets or the strategy of the overall business;

 

·                  Significant negative industry or economictrends; and/or

 

·                  Significant decline in our stock price for asustained period.

 

If, as a result of the existence of one or more of the above indicatorsof impairment, we determine that the carrying value of intangibles and/orlong-lived assets may not be recoverable, we compare the estimated undiscountedcash flows expected to result from the use of the asset and its eventualdisposition to the asset’s carrying amount. If an amortizable intangible orlong-lived asset is not deemed to be recoverable, we recognize an impairmentloss representing the excess of the asset’s carrying value over its estimatedfair value.

 

**Revenue Recognition -**We recognizerevenue from two primary sources: license fees and services, and customersupport, in accordance with Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition,” as amended and interpreted by SOP 98-9, “Modification ofSOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions.”  Staff Accounting Bulletin(“SAB”) No. 104, “Revenue Recognition,” provides further interpretiveguidance for public companies on the recognition, presentation and disclosureof revenue in financial statements.  Inaddition to the criteria described below, we generally recognize revenue whenan agreement is signed, the fee is fixed or determinable and collectability isreasonably assured.

 

Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting, in accordance with SOP97-2 and SOP 81-1, “Accounting for Long-Term Construction Type Contracts.”  We estimate the percentage-of-completion foreach contract based on the ratio of direct labor hours incurred to totalestimated direct labor hours.  Sinceestimated direct labor hours, and changes thereto, can have a significantimpact on revenue recognition, these estimates are critical and we review themregularly.  We record amounts billed inadvance of services being performed as unearned revenue. Unbilledwork-in-progress represents revenue earned but not yet billable under the termsof the fixed-price contracts. All such amounts are expected to be billed andcollected within 12 months.

 

Wemay encounter budget and schedule overruns on fixed price contracts causedby increased labor or overhead costs. We make adjustments to cost estimates inthe periods in which the facts requiring such revisions become known. We recordestimated losses, if any, in the period in which current estimates of totalcontract revenue and contract costs indicate a loss. If revisions to costestimates are obtained after the balance sheet date but before the issuance ofthe interim or annual financial statements, we make adjustments to the interimor annual financial statements accordingly.

 

In arrangements where the services are not essential to thefunctionality of the delivered software, we recognize license revenue when alicense agreement has been signed, delivery has occurred, the fee is fixed ordeterminable and collectability is reasonably assured. Where applicable, weunbundle and record as revenue fees from multiple element arrangements as theelements are delivered to the extent that vendor specific objective evidence(“VSOE”) of fair value of the undelivered elements exist. If VSOE for theundelivered elements does not exist, we defer fees from such arrangements untilthe earlier of the date that VSOE does exist on the undelivered elements or allof the elements have been delivered.

 

Werecognize revenue from fixed-price service contracts using the proportionalperformance method of accounting, which is similar to the percentage ofcompletion method described above. We recognize revenue from professionalservices provided pursuant to time-and-materials based contracts and trainingservices as the services are performed, as that is when our obligation to ourcustomers under such arrangements is fulfilled.

 

Werecognize customer support, including maintenance revenue, ratably over theservice contract period. When maintenance is bundled with the original licensefee arrangement, its fair value, based upon VSOE, is deferred and recognizedduring the periods when services are provided.

 

**Stock-based Compensation -** We account for stock-based compensationunder Statement of Financial Accounting Standards No. 123(Revised),“Share-Based Payment” (“SFAS 123R”). This statement replaced SFAS No. 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”) and superseded APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  UnderSFAS 

 

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123R, we apply a fair-value-based measurement methodto account for share-based payment transactions with employees and directorsand record compensation cost for all stock awards granted after January 1,2006 and awards modified, repurchased, or cancelled after that date. We recordcompensation costs associated with the vesting of unvested options on astraight-line basis over the vesting period using the guidance under SFAS123R.  Stock-based compensation is anon-cash expense because we settle these obligations by issuing shares of ourcommon stock instead of settling such obligations with cash payments.   Effective January 1, 2006, we accountedfor stock option grants and employee stock purchase plan purchases under SFAS123R.  We used the Black-Scholes model toestimate the fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**Income Taxes**- We account forincome taxes in accordance with SFAS No. 109, “Accounting for IncomeTaxes” (“SFAS 109”). We record deferred tax assets and liabilities for theestimated future tax effects of temporary differences between the tax bases ofassets and liabilities and amounts reported in the accompanying consolidatedbalance sheets, as well as operating loss and tax credit carry-forwards. Wemeasure deferred tax assets and liabilities using enacted tax rates expected tobe applied to taxable income in the years in which those temporary differencesare expected to be recovered or settled. We reduce deferred tax assets by a valuation allowance if, based onavailable evidence, it is more likely than not that these benefits will not berealized.  We evaluate tax benefitsrecorded in our consolidated financial statements and record accruals for anyamounts deemed not probable of being sustained.

 

Effective January 1, 2007, we adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes - aninterpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 prescribes a recognition threshold anda measurement attribute for the financial statement recognition and measurementof tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a taxposition must be more likely than not to be sustained upon examination bytaxing authorities.  There was nomaterial impact on the company’s consolidated financial position and results ofoperations as a result of the adoption of the provisions of FIN 48.

 

As of March 31, 2009 and December 31, 2008, we had noliability for unrecognized tax benefits. We do not believe there will be any material changes to our unrecognizedtax positions over the next twelve months.

 

**Recent Accounting Pronouncements -**In June 2008,the Financial Accounting Standards Board (FASB) issued FASB Staff Position(FSP) Emerging Issues Task Force (EITF) 03-6-1, “Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities.”  This FSP provides that unvested share-based payment awardsthat contain nonforfeitable rights to dividends or dividend equivalents,whether paid or unpaid, are participating securities and shall be included inthe computation of both basic and diluted earnings per share.  We adoptedthe provisions of FSP EITF 03-6-1 on January 1, 2009. There was no impacton earnings per share upon adoption. See Note 3 for additional information.

 

InApril 2008, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) FAS 142-3, “Determination of the Useful Life of IntangibleAssets,” to provide guidance for determining the useful life of recognizedintangible assets and to improve consistency between the period of expectedcash flows used to measure the fair value of a recognized intangible asset andthe useful life of the intangible asset as determined under FASB Statement 142,Goodwill and Other Intangible Assets. The FSP requires that an entity considerits own historical experience in renewing or extending similar arrangements. However,the entity must adjust that experience based on entity-specific factorsincluded in Statement 142. If the company lacks historical experience toconsider for similar arrangements, it would consider assumptions that marketparticipants would use about renewal or extension, as adjusted for theentity-specific factors under Statement 142. We adopted FSP FAS 142-3 as of therequired effective date of January 1, 2009. We did not acquire anyintangible assets during the three months ended March 31, 2009 nor did wehave intangible assets with implicit or explicit renewal or extension terms andthus the adoption of FSP FAS 142-3 had no impact on our financial statements.

 

InApril 2009, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value ofFinancial Instruments,” to require, on an interim basis, disclosures about thefair value of financial instruments for public entities. FSP FAS 107-1 and APB28-1 is effective for interim and annual periods ending after June 15,2009, with early adoption permitted for periods ending after March 15,2009. An entity may early adopt this FSP only if it concurrently adopts bothFSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activityfor the Asset or Liability Have Significantly Decreased and IdentifyingTransactions That Are Not Orderly,” and FSP FAS 115-2 and FAS 124-2,“Recognition and Presentation of Other-Than-Temporary Impairments.” We intendto adopt FSP FAS 107-1 and APB 28-1 effective June 30, 2009.

 

**NOTE 2 – GOODWILL AND INTANGIBLE ASSETS**

 

We recorded goodwill as a result of three acquisitions which occurredover the period from November 2003 to November 2004. We acquired CMSin November 2003, TSE in October 2004 and Evolving Systems U.K. in November 2004.

 

Changes in the carrying amount of goodwill byreporting unit were as follows (in thousands):

 

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| ** **                                            | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|----------------------|------------|-----------|------------|
| ** **                                            | ** ** | **US**                   | ** ** | **UK**               | ** ** | **US**    | ** ** | **UK** | ** ** | **Goodwill** | ** ** |
| Balance as of December 31, 2008                  |       | $                        | —     |                 | $          | 6,611     |       | $ | 6,033 |   | $ | 8,167 |   | $ | 20,811 |   |
| Effects of changes in foreign currency exchange rates |       | —                   |       | (121                 | )          | —    |       | (149 | ) | (270 | ) |
| Balance as of March 31, 2009                     |       | $                        | —     |                 | $          | 6,490     |       | $ | 6,033 |   | $ | 8,018 |   | $ | 20,541 |   |

 

We conducted our annual goodwill impairmenttest as of July 31, 2008, and we determined that goodwill was not impairedas of the test date. From July 31, 2008 through March 31, 2009, noevents have occurred that we believe may have impaired goodwill.

 

We amortized identifiable intangible assetson a straight-line basis over estimated lives ranging from one to seven yearsand include the cumulative effects of foreign currency exchange rates.  As of March 31, 2009 and December 31,2008, identifiable intangibles were as follows (in thousands):

 
| ** **                | ** ** | **March 31, 2009** | ** **  | **December 31, 2008**    | ** ** | **Weighted-**             | ** ** |
|---------------------------|------------|-------------------------|-------------|-------------------------------|------------|---------------------------|------------|
| ** **                | ** ** | **(1)  Gross  Amount**  | ** **  | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average Amortization  Period** | ** ** |
| Purchased software        |       | $                       | 1,560       |                          | $          | 966                       |       | $ | 594 |   | $ | 1,583 |   | $ | 902 |   | $ | 681 |   | 4.6  yrs |   |
| Purchased licenses        |       | 227                     |        | 227                           |       | —                    |       | 227 |   | 227 |   | — |   | 2.3  yrs |   |
| Trademarks and tradenames |       | 637                     |        | 250                           |       | 387                       |       | 649 |   | 232 |   | 417 |   | 7.0  yrs |   |
| Business partnerships     |       | 104                     |        | 57                            |       | 47                        |       | 106 |   | 53 |   | 53 |   | 5.0  yrs |   |
| Customer relationships    |       | 2,951                   |        | 1,817                         |       | 1,134                     |       | 2,986 |   | 1,763 |   | 1,223 |   | 5.3  yrs |   |
|                      |       | $                       |  5,479 |                          | $          | 3,317                     |       | $ | 2,162 |   | $ | 5,551 |   | $ | 3,177 |   | $ | 2,374 |   | 5.2  yrs |   |

 

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(1) Changes in intangible values as of March 31, 2009 compared to December 31,2008 are the direct result of changes in foreign currency exchange rates forthe periods then ended.

 

Amortization expense of identifiable intangible assets was $0.2 and$0.4 million for the three months ended March 31, 2009 and 2008,respectively.  As Evolving Systems U.K.uses the British Pound Sterling as its functional currency, the amount offuture amortization actually recorded will be based upon exchange rates ineffect at that time. Expected future amortization expense related toidentifiable intangibles based on our carrying amount as of March 31, 2009was as follows (in thousands):

 
| **Twelve months ending March 31,** | ** ** | ** ** | ** **  |
|-----------------------------------------|------------|------------|-------------|
| 2010                                    |       | $          | 656         |   |
| 2011                                    |       | 632        |        |
| 2012                                    |       | 426        |        |
| 2013                                    |       | 358        |        |
| 2014                                    |       | 90         |        |
|                                    |       | $          |  2,162 |   |

 

**NOTE 3 – EARNINGS PER COMMON SHARE**

 

We compute basic earnings per share (“EPS”) bydividing net income or loss available to common stockholders by the weightedaverage number of shares outstanding during the period, including common stockissuable under participating securities, such as the Series B ConvertibleRedeemable Preferred Stock (“Series B Preferred Stock”). We computediluted EPS using the weighted average number of shares outstanding, includingparticipating securities, plus all potentially dilutive common stockequivalents. Common stock equivalents consist of stock options.

 

OnJanuary 1, 2009, we adopted Financial Accounting Standards Board (“FASB”)Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) 03-6-1, “DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities.” This FSP provides that unvested share-based paymentawards that contain non-forfeitable rights to dividends or dividendequivalents, whether paid or unpaid, are participating securities and shall beincluded in the computation of both basic and diluted earnings pershare.   Upon adoption, both basic and diluted income per sharefor the first quarter of 2009 and full year 2008 remained unchanged.

 

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The following is the reconciliation of thedenominator of the basic and diluted EPS computations (in thousands):

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Basic income (loss) per common and preferred share:              |       |                                  |       |   |   |
| Net income (loss) available to common and preferred shareholders |       | $                                     | 969        |   | $ | (244 | ) |
| Weighted average common shares outstanding                       |       | 19,529                                |       | 18,866 |   |
| Participating securities                                         |       | —                                |       | 496 |   |
| Basic weighted average shares outstanding                        |       | 19,529                                |       | 19,362 |   |
| Basic income (loss) per common and preferred share               |       | $                                     | 0.05       |   | $ | (0.01 | ) |
|                                                             |       |                                  |       |   |   |
| Diluted income (loss) per common and preferred share:            |       |                                  |       |   |   |
|                                                             |       |                                  |       |   |   |
| Net income (loss) available to common and preferred shareholders |       | $                                     | 969        |   | $ | (244 | ) |
| Weighted average common shares outstanding                       |       | 19,529                                |       | 18,866 |   |
| Participating securities                                         |       | —                                |       | 496 |   |
| Effect of dilutive securities – options                     |       | 266                                   |       | — |   |
| Diluted weighted average shares outstanding                      |       | 19,795                                |       | 19,362 |   |
| Diluted income (loss) per common and preferred share             |       | $                                     | 0.05       |   | $ | (0.01 | ) |

 

Weighted average options to purchase 1.8 millionshares of common stock were excluded from the dilutive stock calculation forthe three months ended March 31, 2008, as their effect would have beenanti-dilutive as a result of the net loss for the period.  Weighted average options to purchase 3.8million and 2.7 million shares of common stock were excluded from the dilutivestock calculation for the three months ended March 31, 2009 and 2008,respectively, because their exercise prices were greater than the average fairvalue of our common stock for the period.

 

**NOTE 4 — SHARE-BASED COMPENSATION**

 

Weadopted SFAS 123R effectiveJanuary 1, 2006 using the modified prospective method.  We recognized $0.2 million of compensationexpense in the consolidated statements of operations for each of the threemonths ended March 31, 2009 and 2008, with respect to our stock-basedcompensation plans.  The following tablesummarizes stock-based compensation expenses recorded in the statement ofoperations (in thousands):

 

| ** **                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Cost of license fee and services, excluding depreciation and  amortization |       | $                                     | 17         |   | $ | 17 |   |
| Cost of customer support, excluding depreciation and amortization          |       | 2                                     |       | 2 |   |
| Sales and marketing                                                        |       | 37                                    |       | 42 |   |
| General and administrative                                                 |       | 123                                   |       | 146 |   |
| Product development                                                        |       | 22                                    |       | 21 |   |
|                                                                       |       | $                                     | 201        |   | $ | 228 |   |

 

**Stock Option Plan**

 

In January 1996, our stockholders approved an Amended and RestatedStock Option Plan (the “Option Plan”). Under the Option Plan, as amended, 8,350,000 shares were reserved forissuance.  Options issued under theOption Plan were at the discretion of the Board of Directors, including thevesting provisions of each stock option granted. Options were granted with anexercise price equal to the closing price of our common stock on the date ofgrant, generally vest over four years and expire no more than ten years fromthe date of grant. The Option Plan terminated on January 18, 2006; optionsgranted before that date were not affected by the plan termination.  At March 31, 2009 and 2008, 3.6 millionand 3.9 million options remained outstanding under the Option Plan,respectively.

 

In March 2007, upon the hiring of our Vice President of World WideSales and Marketing, in accordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv),the board of directors approved an inducement award under a stand-alone equityincentive plan.  We

 

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granted 100,000 non-qualified options to purchase shares of our commonstock at an exercise price equal to the closing price of our common stock onthe date of grant.  The options vest overfour years and expire ten years from the date of grant. At March 31, 2009and 2008, 100,000 options remained outstanding under this plan.

 

In June 2007, our stockholders approved the 2007 Stock IncentivePlan (the “2007 Stock Plan”).  A maximumof 2,000,000 shares may be issued under the 2007 Stock Plan.  Awards permitted under the 2007 Stock Planinclude:  Stock Options, StockAppreciation Rights, Restricted Stock, Restricted Stock Units, PerformanceAwards and Other Stock-Based Awards. Awards issued under the 2007 Stock Plan are at the discretion of theBoard of Directors.  As applicable,awards are granted with an exercise price equal to the closing price of ourcommon stock on the date of grant, generally vest over four years and expire nomore than ten years from the date of grant. At March 31, 2009 and 2008, 1.0 million and 0.7 million optionsremained outstanding under the 2007 Stock Plan, respectively.

 

In December 2008, under the 2007 Stock Plan, we awarded a total of105,000 shares of restricted stock to members of our board of directors andsenior management. There were no issuances of restricted stock during the threemonths ended March 31, 2009 or 2008. During the three months ended March 31,2009 and 2008, 21,000 and 14,000 shares of restricted stock vested,respectively.  There were no forfeituresof restricted stock during the three months ended March 31, 2009 and 2008.The fair market value for share-based compensation expensing is equal to theclosing price of our common stock on the date of grant.  The restrictions on the stock award arereleased generally over four years for senior management and over one year forboard members.

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes model.  TheBlack-Scholes model uses four assumptions to calculate the fair value of eachoption grant.  The expected term of shareoptions granted is derived using the simplified method as prescribed by the SECStaff Accounting Bulletin 107 (“SAB 107”), “Share-Based Payment”, which weadopted in January 2008. The risk-free interest rate is based upon therate currently available on zero-coupon U.S. Treasury instruments with aremaining term equal to the expected term of the stock options.  The expected volatility is based uponhistorical volatility of our common stock over a period equal to the expectedterm of the stock options.  The expecteddividend yield is zero and is based upon historical and anticipated payment ofdividends.  The weighted-averageassumptions used in the fair value calculations are as follows:

 
| ** **              | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Expected term (years)   |       | 5.3                                   |       | 6.2 |   |
| Risk-free interest rate |       | 1.9                                   | %          | 2.7 | % |
| Expected volatility     |       | 79.2                                  | %          | 101.9 | % |
| Expected dividend yield |       | 0                                     | %          | 0 | % |

 

The following is a summary of stock option activity under the plans forthe three months ended March 31, 2009:

 
| ** **                                    | ** ** | ** **         | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **         | ** ** |
|-----------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------|------------|--------------------|------------|
| ** **                                    | ** ** | ** **         | ** ** | ** **    | ** ** | **Average**     | ** ** | ** **         | ** ** |
| ** **                                    | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Remaining**   | ** ** | **Aggregate**      | ** ** |
| ** **                                    | ** ** | **Number of**      | ** ** | **Average**   | ** ** | **Contractual** | ** ** | **Intrinsic**      | ** ** |
| ** **                                    | ** ** | **Shares**         | ** ** | **Exercise**  | ** ** | **Term**        | ** ** | **Value**          | ** ** |
| ** **                                    | ** ** | **(in thousands)** | ** ** | **Price**     | ** ** | **(Years)**     | ** ** | **(in thousands)** | ** ** |
| Options outstanding at December 31, 2008 |       | 4,654              |       | $             | 2.81       |            |       |               | $          | 78 |   |
| Options granted                               |       | 70                 |       | $             | 0.93       |            |       |               |       |   |
| Less options forfeited                        |       | (9                 | )          | $             | 2.59       |            |       |               |       |   |
| Options outstanding at March 31, 2009    |       | 4,715              |       | $             | 2.78       |            | 5.52       |               | $          | 537 |   |
|                                          |       |               |       |          |       |            |       |               |       |
| Options exercisable at March 31, 2009    |       | 3,743              |       | $             | 3.10       |            | 4.66       |               | $          | 318 |   |

 

The weighted-average grant-date fair value of stock options grantedduring the three months ended March 31, 2009 and 2008 was $0.61 and $1.67,respectively.

 

As of March 31, 2009, there was approximately $1.3 million oftotal unrecognized compensation costs related to unvested stock options.  These costs are expected to be recognizedover a weighted average period of 2.4 years.

 

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The total fair value of stock options vested during the three monthsended March 31, 2009 and 2008 was $0.2 million and $0.3 million,respectively.

 

The deferred income tax benefits from stock option expense related toEvolving Systems U.K. totaled approximately $15,000 for the three months ended March 31,2009 and 2008.

 

Cash received from stock option exercises for each of the three monthsended March 31, 2009 and 2008 was $0.

 

**Employee Stock Purchase Plan**

 

Under the Employee Stock Purchase Plan (“ESPP”), we are authorized toissue up to 1,100,000 shares of our common stock to full-time employees, nearlyall of whom are eligible to participate. Under the terms of the ESPP, employeesmay elect to have up to 15% of their gross compensation withheld throughpayroll deduction to purchase our common stock, capped at $25,000 annually. Thepurchase price of the stock is 85% of the lower of the market price at thebeginning or end of each three-month participation period. As of March 31,2009, there were 224,000 shares available for purchase.  For each of the three months ended March 31,2009 and 2008, we recorded compensation expense of $5,000 and $6,000,respectively, associated with grants under the ESPP which includes the fairvalue of the look-back feature of each grant as well as the 15% discount on thepurchase price.  This expense fluctuateseach period based upon employee participation.

 

The fair value of each purchase made under our ESPP is estimated on thedate of purchase using the Black-Scholes model. The Black-Scholes model uses four assumptions to calculate the fairvalue of each purchase.  The expectedterm of each purchase is based upon the three-month participation period ofeach offering.  The risk-free interestrate is based upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of eachoffering.  The expected volatility isbased upon historical volatility of our common stock.  The expected dividend yield is based uponhistorical and anticipated payment of dividends.  The weighted average assumptions used in thefair value calculations are as follows:

 
| ** **              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **2009**                               | ** ** | **2008** | ** ** |
| Expected term (years)   |       | 0.25                                   |       | 0.25 |   |
| Risk-free interest rate |       | 0.2                                    | %          | 1.3 | % |
| Expected volatility     |       | 65.3                                   | %          | 70.4 | % |
| Expected dividend yield |       | 0                                      | %          | 0 | % |

 

Cash received from employee stock plan purchases for the three monthsended March 31, 2009 and 2008 was $15,000 and $16,000, respectively.  We issued shares related to the ESPP of23,000 and 11,000 for the three months ended March 31, 2009 and 2008,respectively.

 

**NOTE 5 – CONCENTRATION OF CREDIT RISK**

 

For the three months ended March 31, 2009, onesignificant customer (defined as contributing at least 10%) accounted for 26%of total revenue.  The customer is alarge telecommunications operator located in the U.S.  For the three months ended March 31,2008, two significant customers (defined as contributing at least 10%)accounted for 30% (18% and 12%) of total revenue.  These customers are large telecommunicationsoperators located in the U.S. and U.K., respectively.

 

As of March 31, 2009, one significant customeraccounted for approximately 16% of contract receivables and unbilled work-in-progress.  This customer is a largetelecommunications operator located in the U.S. At December 31, 2008, one significantcustomer accounted for approximately 45% of contract receivableswork-in-progress.  This customer is a largetelecommunications operator located in the U.S.

 

**NOTE 6 – LONG-TERM DEBT**

 

Long-termdebt consists of the following (in thousands):

 

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| ** **                                                                                                                                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                          | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                                                                                          | ** ** | ** **         | ** ** | ** **            | ** ** |
| Senior term loan with financial institution, interest at a fixed rate  of 8.25%, principal installments and interest payments are due monthly with  final maturity on February 22, 2010. The loan is secured by substantially  all of our assets.              |       | $                  | 1,833      |                  | $          | 2,333 |   |
| Long-term unsecured subordinated notes payable, interest ranges from  11-14% with a weighted average rate of 12.77% and 13.72% at March 31,  2009 and December 31, 2008, respectively, accrued interest and principal  are due in full May 16, 2011. |       | 3,918              |       | 4,550                 |       |
| Total debt                                                                                                                                                                                                                                                          |       | 5,751              |       | 6,883                 |       |
| Less current portion                                                                                                                                                                                                                                                |       | (1,833             | )          | (2,000                | )          |
| Long-term debt, excluding current portion                                                                                                                                                                                                                           |       | $                  | 3,918      |                  | $          | 4,883 |   |

 

On February 22, 2008, we replaced our existingsenior term note and senior revolving facility with a new $4.0 million seniorterm loan, a $1.0 million U.S. revolving credit facility (“U.S. RevolvingFacility”) and a $5.0 million U.K. revolving credit facility (“U.K. RevolvingFacility”).  On December 18, 2008 wemodified our U.S. and U.K. Revolving Facilities. The U.S. Revolving Facility isnow a $2.5 million credit facility and the U.K. Revolving Facility is now a$3.5 million facility. All other terms and conditions remained the same. Therehave been no borrowings on either facility and therefore there are nooutstanding balances on either facility as of March 31, 2009.

 

We used proceeds from the $4.0 million seniorterm loan to pay down our prior senior term note balance of approximately $3.8million.  The $4.0 million senior termloan bears interest at a fixed rate of 8.25% and is payable in 24 equal monthlyinstallments of principal, plus all accrued interest, beginning March 10,2008, with final maturity on February 22, 2010.  The senior term loan is secured bysubstantially all assets of Evolving Systems, Inc. and subjects us tocertain affirmative and negative covenants, including financial covenantsrelated to maintaining a specified ratio of debt to EBITDA, as defined, minimumEBITDA, minimum liquidity, and a specified fixed charge ratio.

 

The remaining scheduled principal payments as of March 31, 2009 onour long-term debt are as follows (in thousands):

 

| **Year ending March 31,** | ** ** | ** ** | ** **  |
|--------------------------------|------------|------------|-------------|
| 2010                           |       | $          | 1,833       |   |
| 2011                           |       | —     |        |
| 2012                           |       | 3,918      |        |
|                           |       | $          |  5,751 |   |

 

Our $2.5 million U.S. Revolving Facilitybears interest at Prime Rate plus 0.5%. Prime Rate was 3.25% as of March 31, 2009.  Borrowings under the senior revolvingfacilities are limited to a percentage of our eligible accounts receivable andcash.  The U.S. Revolving Facility issecured by all assets of Evolving Systems, Inc. and is subject to the samecovenants as the senior term loan.  Allaccrued interest on outstanding borrowings under the U.S. Revolving Facility ispaid monthly, with any outstanding balance due with a final maturity of February 22,2011.  As of March 31, 2009, we had$2.5 million in availability, but no borrowing outstanding under this U.S.Revolving Facility.

 

Our $3.5 million U.K. Revolving Facilitybears interest at Prime Rate plus 0.5%. Prime Rate was 3.25% as of March 31, 2009.  Borrowings under the U.K. Revolving Facilityare limited to a percentage of our eligible accounts receivable and cash.  The U.K. Revolving Facility is secured by allassets of Evolving Systems Holdings Ltd. and Evolving Systems Ltd. and is subjectto the same covenants as the Senior Term Loan. All accrued interest on outstanding borrowings under the U.K. RevolvingFacility is paid monthly, with any outstanding balance due with a finalmaturity of February 22, 2011.  Asof March 31, 2009, we had $3.5 million in availability, but no borrowingoutstanding under this U.K. Revolving Facility.

 

In connection with the replacement of ourexisting senior term note and senior revolving facility with the new seniorterm loan and U.S. Revolving Facility and the U.K. Revolving Facility, duringthe three months ended March 31, 2008, we recorded a write-off of debtissuance costs associated with the retired senior debt of approximately $0.3million.  Additionally, we capitalizeddebt issuance costs related to our new senior debt of approximately $0.3million.  These newly capitalized debtissuance costs will be amortized over the term of the new senior debt.

 

On March 11, 2009, we paid $2.0 million against our subordinatednotes, including accrued non-current interest. This debt payment wasunscheduled and reduced balances classified as long-term as of March 31,2009.

 

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On February 22, 2008, we paid $272,000to retire $279,000 of subordinated debt and related accrued interest held bytwo of our subordinated note holders. The retirements included principal of $217,000 and accrued interest of$62,000.  The $7,000 gain on extinguishmentof this debt is reflected within our other income (expense) on the consolidatedstatements of operations.  On February 22,2008, we also paid $728,000 in accrued interest to the remaining subordinatednote holders.

 

The remaining long-term unsecured subordinated notes payable of $3.9million, at March 31, 2009, accrued interest at 11% through December 31,2007 and 14% thereafter.  Interestexpense was recognized using an effective rate of 12.77% through March 31,2009 and 13.72% through December 31, 2008.

 

Theunsecured subordinated notes are subordinate to the senior note and seniorrevolving credit facility.  The unsecuredsubordinated notes payable agreements subject us to certain affirmative andnegative covenants; however, certain covenants are not in effect until thesenior note and senior revolving credit facility are paid in full.  Outstanding amounts of the unsecuredsubordinated notes may be accelerated upon the occurrence of an uncured eventof default or if we achieve certain minimum cash thresholds.  Accrued interest on the unsecuredsubordinated notes payable is separately reflected on the balance sheet under“Other long-term obligations.”

 

Wewere in compliance with all of our debt covenants as of March 31, 2009 andDecember 31, 2008.

 

**NOTE 7 – INCOME TAXES**

 

We recorded net income tax expense of $5,000 for thethree months ended March 31, 2009 and a net income tax benefit of $74,000for the three months ended March 31, 2008. The net expense during the three months ended March 31, 2009consisted of income tax expense of $56,000 and a deferred tax benefit of$51,000. The net benefit during the three months ended March 31, 2008consisted of a deferred tax benefit of $74,000, related to our U.K.-basedoperations.

 

In conjunction with the acquisition of EvolvingSystems U.K., we recorded certain identifiable intangible assets.  Since the amortization of these identifiableintangibles is not deductible for income tax purposes, we established along-term deferred tax liability of $4.6 million at the acquisition date forthe expected difference between what would be expensed for financial reportingpurposes and what would be deductible for income tax purposes. As of March 31,2009 and December 31, 2008, this component of the deferred tax liabilitywas $0.6 million and $0.7 million, respectively.  This deferred tax liability relates toEvolving Systems U.K., and has no impact on our ability to recover U.S.-baseddeferred tax assets.  This deferred taxliability will be recognized as a reduction of deferred income tax expense asthe identifiable intangibles are amortized.

 

Asof March 31, 2009 and December 31, 2008 we continued to maintain afull valuation allowance on the domestic net deferred tax asset as we havedetermined it is more likely than not that we will not realize our domesticdeferred tax assets.  Such assetsprimarily consist of certain net operating loss carryforwards.  We assessed the realizability of our domesticdeferred tax assets using all available evidence.  In particular, we considered both historicalresults and projections of profitability for the reasonably foreseeable futureperiods.  We are required to reassess ourconclusions regarding the realization of our deferred tax assets at eachfinancial reporting date. A future evaluation could result in a conclusion thatall or a portion of the valuation allowance is no longer necessary which couldhave a material impact on our results of operations and financial position.

 

Effective January 1, 2007, we adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes - aninterpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 prescribes a recognition threshold anda measurement attribute for the financial statement recognition and measurementof tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a taxposition must be more likely than not to be sustained upon examination bytaxing authorities.  There was not amaterial impact on the company’s consolidated financial position and results ofoperations as a result of the adoption of the provisions of FIN 48.

 

On January 1, 2007, we recorded a FIN 48 transition adjustmentconsisting of a $0.4 million decrease in our deferred tax assets related toResearch and Development Tax Credits that was offset by a correspondingdecrease in our valuation allowance because we determined that it was not morelikely than not that our deferred tax assets will be realized.  As of March 31, 2009 and December 31,2008, we had no liability for unrecognized tax benefits.  We do not believe there will be any materialchanges our unrecognized tax positions over the next twelve months.

 

We conduct business globally and, as a result, Evolving Systems, Inc.or one or more of our subsidiaries file income tax returns in the U.S. federaljurisdiction and various state and foreign jurisdictions.  In the normal course of business, we aresubject to examination by taxing authorities throughout the world, namely theUnited Kingdom, Germany and India.  Withfew exceptions, we are no longer subject to U.S. federal, state and local, ornon-U.S. income tax examinations for years before 2005.

 

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**NOTE 8 – STOCKHOLDERS’ EQUITY**

 

On February 25, 2008, holders of 461,758 sharesof Series B Preferred Stock with a carrying value of $5.4 million, orapproximately 96% of the outstanding preferred stock, converted their shares ofpreferred stock into 1,385,274 shares of our common stock in accordance withthe conversion provisions of the Series B Preferred Stock.  On March 19, 2008, a holder of 16,992shares of Series B Preferred Stock with a carrying value of $0.2 million,which represented the remainder of the outstanding preferred stock, convertedhis shares of preferred stock into 50,976 shares of our common stock inaccordance with the conversion provisions of the Series B PreferredStock.  As we previously includedthe Series B Convertible Preferred Stock as a participating security forbasic EPS purposes, these conversions did not change our basic or diluted EPScalculations.

 

                On March 4, 2009 our Board of Directors adopted a stockholder rightsplan that is designed to strengthen the ability of the Board of Directors toprotect Evolving Systems’ stockholders.  The plan was not adopted inresponse to any unsolicited offer or takeover attempt. Under the plan, eachcommon stockholder of the Company at the close of business on March 16,2009 will receive a dividend of one right for each share of the Company’scommon stock held of record on that date.  Each right will entitle theholder to purchase from the Company, in certain circumstances, oneone-hundredth of a share of newly-created Series C junior participatingpreferred stock of the Company for an initial purchase price of $8.00 pershare. The rights distribution will not be taxable to stockholders and thedistribution of rights under the plan will not interfere with the Company’sbusiness plans or be dilutive to or affect the Company’s reported per shareresults.

 

**NOTE 9 – SEGMENT INFORMATION**

 

In accordance with SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information,” we define operatingsegments as components of an enterprise for which separate financialinformation is reviewed regularly by the chief operating decision-making groupto evaluate performance and to make operating decisions. We have identified ourChief Executive Officer and Chief Financial Officer as our chief operatingdecision-makers (CODM). These chief operating decision makers review revenuesby segment and review overall results of operations.

 

We currently operate our business as two operatingsegments based on revenue type:  licensefees and services revenue and customer support revenue (as shown on theconsolidated statements of operations). License fees and services (L&S) revenue represents the fees receivedfrom the license of software products and those services directly related tothe delivery of the licensed products, such as fees for custom development andintegration services.  Customer support(CS) revenue includes annual support fees, recurring maintenance fees, fees formaintenance upgrades and warranty services. Warranty services that are similar to software maintenance services aretypically bundled with a license sale. Total assets by segment have not beendisclosed as the information is not available to the chief operatingdecision-making group.

 

Segment information is as follows (in thousands):

 
| ** **                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **Revenue**                                                                 |       |                                  |       |   |   |
| License fees and services                                                   |       | $                                     | 4,745      |   | $ | 4,832 |   |
| Customer support                                                            |       | 4,098                                 |       | 4,295 |   |
| Total revenue                                                               |       | 8,843                                 |       | 9,127 |   |
|                                                                        |       |                                  |       |   |   |
| **Revenue less costs of revenue, excluding depreciation  and amortization** |       |                                  |       |   |   |
| License fees and services                                                   |       | 3,068                                 |       | 2,608 |   |
| Customer support                                                            |       | 2,665                                 |       | 2,802 |   |
|                                                                        |       | 5,733                                 |       | 5,410 |   |
| **Unallocated Costs**                                                       |       |                                  |       |   |   |
| Other operating expenses                                                    |       | 4,015                                 |       | 4,680 |   |
| Depreciation and amortization                                               |       | 327                                   |       | 610 |   |
| Interest income                                                             |       | (5                                    | )          | (78 | ) |
| Interest expense                                                            |       | 257                                   |       | 336 |   |
| Loss on extinguishment of debt                                              |       | —                                |       | 290 |   |
| Foreign currency exchange (gain) loss                                       |       | 165                                   |       | (110 | ) |
| **Income (loss) before income taxes**                                       |       | $                                     | 974        |   | $ | (318 | ) |

 

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***GeographicRegions***

 

We are headquartered inEnglewood, a suburb of Denver, Colorado. We use customer locations as the basis for attributing revenues toindividual countries.  We provideproducts and services on a global basis through our headquarters and ourLondon-based Evolving Systems U.K. subsidiary. Additionally, personnel in Bangalore, India provide software developmentservices to our global operations. Financial information relating to operations by geographic region is asfollows (in thousands):

 
| ** **     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------|------------|---------------------------------------|------------|
| ** **     | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **     | ** ** | **L&S**                           | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| United States  |       | $                                     | 683        |   | $ | 2,570 |   | $ | 3,253 |   | $ | 399 |   | $ | 2,470 |   | $ | 2,869 |   |
| United Kingdom |       | 687                                   |       | 494 |   | 1,181 |   | 1,193 |   | 682 |   | 1,875 |   |
| Other          |       | 3,375                                 |       | 1,034 |   | 4,409 |   | 3,240 |   | 1,143 |   | 4,383 |   |
| Total revenues |       | $                                     | 4,745      |   | $ | 4,098 |   | $ | 8,843 |   | $ | 4,832 |   | $ | 4,295 |   | $ | 9,127 |   |

 
| ** **                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| **Long-lived assets, net**   |       |               |       |                  |       |
| United States                |       | $                  | 7,045      |                  | $          | 7,060 |   |
| United Kingdom               |       | 16,896             |       | 17,327                |       |
| Other                        |       | 83                 |       | 75                    |       |
| Total long-lived assets, net |       | $                  | 24,024     |                  | $          | 24,462 |   |

 

Financial information relating to product groupingswas as follows (in thousands):

 
| ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **Revenue**         |       |                                  |       |   |   |
| Activation          |       | $                                     | 4,842      |   | $ | 4,692 |   |
| Numbering solutions |       | 3,388                                 |       | 2,933 |   |
| Mediation           |       | 613                                   |       | 1,502 |   |
| Total revenues      |       | $                                     | 8,843      |   | $ | 9,127 |   |

 

**NOTE 10 — COMMITMENTS AND CONTINGENCIES**

 

**(a)****          ****OtherCommitments**

 

As permitted under Delaware law, we have agreementswith officers and directors under which we agree to indemnify them for certainevents or occurrences while the officer or director is, or was, serving at ourrequest in this capacity. The term of the indemnification period is indefinite.There is no limit on the amount of future payments we could be required to makeunder these indemnification agreements; however, we maintain Director andOfficer insurance policies, as well as an Employment Practices LiabilityInsurance Policy, that may enable us to recover a portion of any amounts paid.As a result of our insurance policy coverage, we believe the estimated fairvalue of these indemnification agreements is minimal. Accordingly, there wereno liabilities recorded for these agreements as of March 31, 2009 or December 31,2008.

 

We enter into standard indemnification terms withcustomers and suppliers, as discussed below, in the ordinary course ofbusiness.  As we may subcontract thedevelopment of deliverables under customer contracts, we could be required toindemnify customers for work performed by subcontractors. Depending upon thenature of the customer indemnification, the potential amount of future paymentswe could be required to make under these indemnification agreements may beunlimited. We may be able to recover damages from a subcontractor if theindemnification to customers results from the subcontractor’s failure toperform. To the extent we are unable to recover damages from a subcontractor, wecould be required to reimburse the indemnified party for the full amount. Wehave never incurred costs to defend lawsuits or settle claims relating toindemnification arising out of subcontractors’ failure to perform. As a result,we believe the estimated fair value of these agreements is minimal.Accordingly, there were no liabilities recorded for these agreements as of March 31,2009 or December 31, 2008.

 

Our standard license agreements contain productwarranties that the software will be free of material defects and will operatein accordance with the stated requirements for a limited period of time.  The product warranty provisions require us tocure any defects through any reasonable means. We believe the estimated fair value of the product warranty provisionsin the license 

 

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agreementsin place with our customers is minimal. Accordingly, there were no liabilities recorded for these productwarranty provisions as of March 31, 2009 or December 31, 2008.

 

Our software arrangements generally include aproduct indemnification provision whereby we will indemnify and defend acustomer in actions brought against the customer for claims that our productsinfringe upon a copyright, trade secret, or valid patent. We have nothistorically incurred any significant costs related to product indemnificationclaims. Accordingly, there were no liabilities recorded for theseindemnification provisions as of March 31, 2009 or December 31, 2008.

 

In relation to the acquisitions of Evolving SystemsU.K., TSE and CMS, we agreed to indemnify certain parties from any losses,actions, claims, damages or liabilities (or actions in respect thereof)resulting from any claim raised by a third party.  We do not believe that there will be anyclaims related to these indemnifications. Accordingly, there were noliabilities recorded for these agreements as of March 31, 2009 or December 31,2008.

 

**(b)****          ****Litigation**

 

During the fourth quarter of 2006, a previous vendor filed a complaintin the Superior Court of New Jersey against us asserting we breached certainprovisions of a license agreement.  SeeNote 12 — Subsequent Events.

 

We are involved in various other legal matters arising in the normalcourse of business.  Losses, includingestimated costs to defend, were recorded for these matters to the extent theywere probable of loss and the amount of loss could be reasonably estimated.

 

**NOTE 11 – RELATED PARTY TRANSACTIONS**

 

During 2008, we entered into a consulting agreement with Stephen K.Gartside, Jr., our previous President and CEO and current Chairman of theBoard.  Under the agreement, we paid Mr. Gartsidean annual fee of $20,000 for consulting services provided to us during2008.  We had current obligations in theconsolidated balance sheets, under the agreement, of $0 and $5,000 as of March 31,2009 and December 31, 2008, respectively. We recorded $5,000 of general and administrative expense in theconsolidated statements of operations, related to this agreement, for the threemonths ended March 31, 2008. This contract terminated December 31,2008.

 

**NOTE 12 – SUBSEQUENT EVENTS**

 

On April 20, 2009, we made an optionalpre-payment of $1.0 million to the holders of our subordinated notes. This paymentwas unscheduled and reduced balances classified as long-term as of March 31,2009.

 

On April 10, 2009, we settled our litigation with a previousvendor and the matter pending in the United States District Court of New Jerseywas dismissed with prejudice.

 

**ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**SPECIALNOTE ABOUT FORWARD-LOOKING STATEMENTS**

 

*This Quarterly Report on Form 10-Q contains forward-lookingstatements that have been made pursuant to the provisions of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations,estimates, and projections about Evolving Systems’ industry, management’sbeliefs, and certain assumptions made by management.  Forward-looking statements include ourexpectations regarding product, services, and maintenance revenue, annualsavings associated with the organizational changes effected in prior years, andshort- and long-term cash needs.  In somecases, words such as “anticipates”, “expects”, “intends”, “plans”, “believes”,“estimates”, variations of these words, and similar expressions are intended toidentify forward-looking statements.  Thestatements are not guarantees of future performance and are subject to certainrisks, uncertainties, and assumptions that are difficult to predict; therefore,actual results may differ materially from those expressed or forecasted in anyforward-looking statements.  Risks anduncertainties of our business include those set forth in our Annual Report on Form 10-Kfor the year ended December 31, 2008 under “Item 1A. Risk Factors” as wellas additional risks described in this Form 10-Q.  Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events, or otherwise.  However, readers should carefully review therisk factors set forth in other reports or documents we file from time to timewith the Securities and Exchange Commission, particularly the Quarterly Reportson Form 10-Q and any Current Reports on Form 8-K.*

 

**OVERVIEW**

 

We are a worldwide provider of software solutionsand services to telecommunications carriers, with 70 network operators in 45countries.  Our customers rely on us todevelop, deploy, enhance, maintain and integrate complex, highly reliablesoftware solutions for a range of Operations Support Systems (“OSS”).  Our activation solution is a leading packagedsolution for service activation in the 

 

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wirelessindustry.

 

We recognize revenue in accordance with theprescribed accounting standards for software revenue recognition undergenerally accepted accounting principles. Our license fees and services revenues fluctuate from period to periodas a result of the timing of revenue recognition on existing projects.

 

**RECENT DEVELOPMENTS**

 

Beginning in the fourth quarter of 2008, the U.S. Dollar strengthenedagainst many other currencies, including the British Pound Sterling and theEuro. As a result, the portion of the Company’s revenue which is denominated inforeign currencies, when converted to U.S. Dollars, is reduced.  At the same time, with more than 50% of theCompany’s operating expenses originating overseas, the strengthening dollarconversely lowers expenses outside of the U.S. The net effect of our foreigncurrency translations for the three months ended March 31, 2009 were a$1.0 million decrease in revenue and a $1.5 million decrease in operatingexpenses versus the three months ended March 31, 2008.

 

Benefiting from our increased cash flow from operations, which is typicallygenerated during the first half of the year, we retired $2.0 million of oursubordinated notes, including accrued non-current interest. This debt paymentwas unscheduled and reduced balances classified as long-term as of December 31,2008.

 

We reported net income of $1.0 million for the three months ended March 31,2009. This is the fourth consecutive quarter in which we have reported netincome and our most profitable 1st quarter sinceour 2003 and 2004 acquisitions of Tertio, TSE and CMS.  Our twelve month backlog decreased to $17.8million including $8.6 million in license and services and $9.2 million incustomer support.

 

**RESULTS OF OPERATIONS**

 

The following table presents the unauditedconsolidated statements of operations reflected as a percentage of totalrevenue.

*** ***
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **REVENUE**                                                                  |       |                                  |       |   |   |
| License fees and services                                                    |       | 54                                    | %          | 53 | % |
| Customer support                                                             |       | 46                                    | %          | 47 | % |
| Total revenue                                                                |       | 100                                   | %          | 100 | % |
|                                                                         |       |                                  |       |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                  |       |   |   |
| Costs of license fees and services, excluding depreciation and  amortization |       | 19                                    | %          | 24 | % |
| Costs of customer support, excluding depreciation and amortization           |       | 16                                    | %          | 16 | % |
| Sales and marketing                                                          |       | 21                                    | %          | 24 | % |
| General and administrative                                                   |       | 16                                    | %          | 16 | % |
| Product development                                                          |       | 8                                     | %          | 12 | % |
| Depreciation                                                                 |       | 2                                     | %          | 3 | % |
| Amortization                                                                 |       | 2                                     | %          | 4 | % |
| Total costs of revenue and operating expenses                                |       | 84                                    | %          | 99 | % |
|                                                                         |       |                                  |       |   |   |
| Income (loss) from operations                                                |       | 16                                    | %          | 1 | % |
|                                                                         |       |                                  |       |   |   |
| Interest income                                                              |       | —                                |       | 1 | % |
| Interest expense                                                             |       | (3                                    | )%         | (4 | )% |
| Loss on debt extinguishment                                                  |       | —                                |       | (3 | )% |
| Foreign currency exchange gain (loss)                                        |       | (2                                    | )%         | 1 | % |
| Other income, net                                                            |       | (5                                    | )%         | (5 | )% |
|                                                                         |       |                                  |       |   |   |
| Income (loss) before income taxes                                            |       | 11                                    | %          | (4 | )% |
| Income tax expense (benefit)                                                 |       | —                                |       | (1 | )% |
| Net income (loss)                                                            |       | 11                                    | %          | (3 | )% |

 

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***Revenue***

 

Revenue is comprised of license fees/services andcustomer support.  License fees andservices revenue represent the fees we receive from the licensing of our softwareproducts and those services directly related to the delivery of the licensedproduct as well as integration and consulting services.  Customer support revenue includesannual support, recurring maintenance, maintenance upgrades and warrantyservices.  Warranty services consist ofmaintenance services and are typically bundled with a license sale and therelated revenue, based on Vendor-Specific Objective Evidence (VSOE). Suchrevenues are deferred and recognized ratably over the warranty period.  The following table presents our revenue byproduct group (in thousands):

** **
| ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **Revenue**         |       |                                  |       |   |   |
| Activation          |       | $                                     | 4,842      |   | $ | 4,692 |   |
| Numbering solutions |       | 3,388                                 |       | 2,933 |   |
| Mediation           |       | 613                                   |       | 1,502 |   |
| Total revenues      |       | $                                     | 8,843      |   | $ | 9,127 |   |

 

Revenue for the three months ended March 31,2009 and 2008 was $8.8 million and $9.1 million, respectively. The decrease of$0.3 million is primarily due to the aforementioned strengthening U.S. Dollarpartially offset by increased revenue from our new *Dynamic SIMAllocation**TM*(“DSA”) andinternational *NumeriTrack®* products.

 

***License Fees and Services***

 

License fees and servicesrevenue decreased $0.1 million, or 2%, to $4.7 million for the three monthsended March 31, 2009 from $4.8 million for the three months ended March 31,2008.  Changes in license fees andservices revenue for the three months ended March 31, 2009 compared to thethree months ended March 31, 2008 included an increase of $0.4 million inrevenue from our numbering solutions products, an increase of $0.4 million inrevenue from our activation products and a decrease of $0.9 million in revenuefrom our mediation products.  This growthin our numbering solutions and activation products groups is due to increasedrevenue from legacy numbering products and DSA, partially offset by lowerrevenue from our existing mediation account base and the effects of thestrengthening U.S. Dollar during the first quarter of 2009 versus 2008.

 

***Customer Support***

 

Customer support revenuedecreased $0.2 million, or 5%, to $4.1 million for the three months ended March 31,2009 from $4.3 million for the three months ended March 31, 2008.  The decrease in customer support revenue wasthe result of activation customer support revenue decreasing $0.3 million.  Customer support revenue from numberingsolutions products increased slightly for the three months ended March 31,2009 compared to the three months ended March 31, 2008. The decrease incustomer support revenue is primarily due to the effects of the strengtheningU.S. Dollar and pricing pressures from customers.

 

***Costs of Revenue, Excluding Depreciation andAmortization***

 

Costs of revenue, excluding depreciation andamortization, consist primarily of personnel costs and other direct costsassociated with these personnel, facilities costs, costs of third-partysoftware and partner commissions.  Costsof revenue, excluding depreciation and amortization, were $3.1 million and $3.7million for the three months ended March 31, 2009 and 2008, respectively.

 

***Costs of License Fees andServices, Excluding Depreciation and Amortization***

 

Costs of license fees and services, excludingdepreciation and amortization, decreased $0.5 million, or 24%, to $1.7 millionfor the three months ended March 31, 2009 from $2.2 million for the threemonths ended March 31, 2008.  As apercentage of license fees and services revenue, costs of license fees andservices, excluding depreciation and amortization, decreased to 35% for thethree months ended March 31, 2009 from 46% for the three months ended March 31,2008.  The decrease in costs wasprimarily due to the effects of the strengthening U.S. Dollar and lower travelexpenses during the first quarter of 2009 versus 2008.

 

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***Costs of Customer Support,Excluding Depreciation and Amortization***

 

Costs of customer support, excluding depreciationand amortization, were $1.4 million and $1.5 million for the three months endedMarch 31, 2009 and 2008, respectively. As a percentage of customer support revenue, costs of customer supportrevenue, excluding depreciation and amortization, were 35% for the three monthsended March 31, 2009 and 2008.  Thedecrease in the costs during the three months ended March 31, 2009 wasrelated to the decrease in customer support revenue during the period and theeffects of the strengthening U.S. Dollar during the first quarter of 2009versus 2008.

 

***Sales and Marketing***

 

Sales and marketing expenses primarily consist ofcompensation costs, including incentive compensation and commissions, travelexpenses, advertising, marketing and facilities expenses.  Sales and marketing expenses decreased $0.3million, or 14%, to $1.9 million for the three months ended March 31, 2009from $2.2 million for the three months ended March 31, 2008.  As a percentage of total revenue, sales andmarketing expenses decreased to 21% for three months ended March 31, 2009from 24% for the three months ended March 31, 2008.  The decrease in the expense and percentage ofrevenue is primarily due to the effects of the strengthening U.S. Dollar duringthe first quarter of 2009 versus 2008, partially offset by higher commissions relatedto increased sales of DSA.

 

***General and Administrative***

 

General and administrative expenses consistprincipally of employee related costs and professional fees for the followingdepartments: facilities, finance, legal, human resources, and certain executivemanagement.  General and administrativeexpenses remained at $1.4 million for the three months ended March 31,2009 and 2008.  As a percentage of totalrevenue, general and administrative expenses remained at 16% for the threemonths ended March 31, 2009 and 2008.

 

***Product Development***

 

Product development expenses consist primarily ofemployee related costs and subcontractor expenses.  Product development expenses decreased $0.4million, or 35%, to $0.7 million from $1.1 million for the three months ended March 31,2009 and 2008, respectively.  As apercentage of revenue, product development expenses for the three months ended March 31,2009 and 2008, decreased to 8% from 12%, respectively.  These decreases are the result of thestrengthening U.S. Dollar during the first quarter of 2009 versus 2008 andincreased reliance on our less expensive Indian work force.

 

***Amortization***

 

Amortization expense consists of amortization ofidentifiable intangible assets acquired through our acquisitions of EvolvingSystems U.K., TSE and CMS.  Amortizationexpense decreased 55% to $0.2 million for the three months ended March 31,2009 from $0.4 million for the three months ended March 31, 2008. As apercentage of revenue, amortization expense for the three months ended March 31,2009 and 2008, decreased to 2% from 4%, respectively. The decrease inamortization expense is due to all CMS, and some TSE intangible assets beingfully amortized during 2008 and the effects of the strengthening U.S. Dollarduring the first quarter of 2009 versus 2008.

 

***Depreciation***

 

Depreciation expense consists of depreciation of long-lived propertyand equipment.  Depreciation expenseremained at $0.2 million for the three months ended March 31, 2009 and2008.  As a percentage of total revenue,depreciation expense for the three months ended March 31, 2009 and 2008,decreased to 2% from 3%, respectively. The decrease is a result of certainassets becoming fully depreciated and the effects of the strengthening U.S.Dollar during the first quarter of 2009 versus 2008.

 

***Interest Expense***

 

Interest expense includes interest expense on ourlong-term debt and capital lease obligations as well as amortization of debtissuance costs.  Interest expense was$257,000 and $336,000 for the three months ended March 31, 2009 and 2008,respectively.  The decrease of $79,000 isdue to lower debt balances as we continue to pay down our subordinated debt andthe continued payments on our senior term loan.

 

***Gain (Loss) on Debt Extinguishment***

 

In February 2008, we wrote-off the remaining debt issuance costsof $297,000 related to our senior term note payable that was replaced duringthe three months ended March 31, 2008. This loss related to the debt issuance cost write-off was partiallyoffset by a $7,000 gain resulting from us paying $272,000 to retire $279,000 ofsubordinated debt and related accrued interest held by two of our subordinatednote holders.  The retirements includedprincipal of $217,000 and accrued interest of $62,000.

 

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***Foreign Currency Exchange Gain (Loss)***

 

Foreign currency transaction gains (losses) resultedfrom transactions denominated in a currency other than the functional currencyof the respective subsidiary and was $(165,000) and $110,000 for the threemonths ended March 31, 2009 and 2008, respectively.  The gains (losses) were generated primarilythrough the remeasurement of certain non-functional currency denominatedfinancial assets and liabilities of our Evolving Systems U.K. subsidiary.

 

***Income Taxes***

 

We recorded income tax expense of $5,000 for thethree months ended March 31, 2009 and an income tax benefit of $74,000 forthe three months ended March 31, 2008. The net income tax expense during the three months ended March 31,2009 consisted of current income tax expense of $56,000 and a deferred foreigntax benefit of $51,000. The net income tax benefit during the three monthsended March 31, 2008 consisted of a deferred foreign tax benefit of$74,000 million related to our UK-based operations.

 

In conjunction with the acquisition of EvolvingSystems U.K., we recorded certain identifiable intangible assets.  Since the identifiable intangibleamortization is not deductible for income tax purposes, we established along-term deferred tax liability of $4.6 million at the acquisition date forthe expected difference between what would be expensed for financial reportingpurposes and what would be deductible for income tax purposes. As of March 31,2009 and December 31, 2008, this deferred tax liability was $0.6 millionand $0.7 million, respectively.  Thisdeferred tax liability is carried on the books of our United Kingdomsubsidiary, and has no impact on our ability to recover our U.S.-based deferredtax assets.  The aforementioned deferredtax liability will be recognized as a reduction of deferred income tax expenseas the identifiable intangibles are amortized.

 

**FINANCIAL CONDITION**

 

 Our workingcapital position decreased $0.9 million to $0.9 million as of March 31,2009 from a $1.8 million as of December 31, 2008.  The decrease in our working capital positionis primarily attributable to existing cash used to retire $2.0 million of oursubordinated notes and accrued non-current interest obligations. This debtpayment was unscheduled and reduced balances classified as long-term as of December 31,2008.

 

**CONTRACTUAL OBLIGATIONS**

 

There have been no material changes to thecontractual obligations as disclosed in our 2008 Annual Report on Form 10-K.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We have historically financed operations throughcash flows from operations and equity transactions.  At March 31, 2009, our principal sourceof liquidity was $8.0 million in cash and cash equivalents as well as $6.0million available under our revolving credit facilities.

 

Net cash provided by operating activities for thethree months ended March 31, 2009 and 2008 was $3.6 million and $2.7million, respectively.  The primarycontribution to the improvement in cash provided by operating activities forthe three months ended March 31, 2009 is due primarily to net income of$1.0 million compared to net loss of $(0.2) million for the three months ended March 31,2008 and increased cash flow from operating assets and liabilities versus thefirst quarter of 2008, partially offset by the aforementioned payment ofaccrued non-current interest related to our subordinated notes, which isclassified as other long-term obligations within operating activities.

 

Net cash used in investing activities during each ofthe three months ended March 31, 2009 and 2008 was $0.2 and $0.3 million,respectively.  The cash used for thethree months ended March 31, 2009 and 2008 was related to purchases ofproperty and equipment.

 

Net cash used in financing activities for the threemonths ended March 31, 2009 and 2008 was $1.1 million and $2.9 million,respectively.  Financing activities inthe three months ended March 31, 2009 consisted primarily of principalpayments on existing debt, of approximately $1.1 million.  Financing activities in the three monthsended March 31, 2008 consisted of principal payments on existing debt, ofapproximately $6.8 million, partially offset by borrowings related to oursenior term loan, of approximately $3.9 million, net of issuance costs.

 

We believe that our current cash and cashequivalents, together with anticipated cash flow from operations andavailability under our revolving line of credit will be sufficient to meet ourworking capital, capital expenditure and financing requirements for at leastthe next twelve months. In making this assessment we considered the following:

 

·                  Our cash andcash equivalents balance at March 31, 2009 of $8.0 million;

 

·                  Theavailability under our revolving credit facilities of $6.0 million at March 31,2009;

 

·                  Ourdemonstrated ability to generate positive cash flows from operations;

 

·                  Our backlog asof March 31, 2009 of approximately $17.8 million, including $8.6 millionin license fees and services and $9.2 million in customer support.

 

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Weare exposed to foreign currency rate risks which impact the carrying amount ofour foreign subsidiaries and our consolidated equity, as well as ourconsolidated cash position due to translation adjustments.  For the three months ended March 31,2009, the effect of exchange rate changes resulted in a $55,000 decrease toconsolidated cash.  During the threemonths ended March 31, 2008, the effect of exchange rate changes resultedin an $8,000 decrease in consolidated cash. We do not currently hedge our foreign currency exposure, but we monitorrate changes and may hedge our exposures if we see significant negative trendsin exchange rates.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

We have no off-balance sheet arrangements that havea material current effect or that are reasonably likely to have a materialfuture effect on our financial condition, changes in financial condition,revenues or expenses, results of operations, liquidity, capital expenditures orcapital resources.

 

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE MARKET RISK DISCLOSURES**

 

In the ordinary course of business, we are exposed to certain marketrisks, including changes in interest rates and foreign currency exchange rates.Uncertainties that are either non-financial or non-quantifiable such aspolitical, economic, tax, other regulatory, or credit risks are not included inthe following assessment of market risks.

 

***Interest Rate Risks***

 

Our cash balances are subject to interest rate fluctuations and as aresult, interest income amounts may fluctuate from current levels.  We could be exposed to interest rate riskrelated to our senior revolving credit facilities entered into in February 2008.  These obligations are variable interest ratenotes based on Prime Rate.  Fluctuationsin Prime Rate affect our interest rates. As of March 31, 2009 and 2008,there was no balance due on our senior revolving credit facilities.

 

***Foreign Currency Risk***

 

We are exposed tofavorable and unfavorable fluctuations of the U.S. dollar (our functionalcurrency) against the currencies of our operating subsidiaries. Any increase(decrease) in the value of the U.S. dollar against any foreign currencythat is the functional currency of one of our operating subsidiaries will causethe parent company to experience unrealized foreign currency translation losses(gains) with respect to amounts already invested in such foreign currencies. In addition, we and our operatingsubsidiaries are exposed to foreign currency risk to the extent that we enterinto transactions denominated in currencies other than our respectivefunctional currencies, such as accounts receivable (including intercompanyamounts) that are denominated in a currency other than their own functionalcurrency. Changes in exchange rates with respect to these items will result inunrealized (based upon period-end exchange rates) or realized foreign currencytransaction gains and losses upon settlement of the transactions. In addition,we are exposed to foreign exchange rate fluctuations related to our operatingsubsidiaries’ monetary assets and liabilities and the financial results offoreign subsidiaries and affiliates when their respective financial statementsare translated into U.S. dollars for inclusion in our consolidated financialstatements. Cumulative translation adjustments are recorded in accumulatedother comprehensive income (loss) as a separate component of equity. As aresult of foreign currency risk, we may experience economic loss and a negativeimpact on earnings and equity with respect to our holdings solely as a resultof foreign currency exchange rate fluctuations.

 

The relationship betweenthe British Pound Sterling, Indian rupee and the U.S. dollar, which is ourfunctional currency, is shown below, per one U.S. dollar:

 
| ** **             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| **Spot rates:**        |       |               |       |                  |       |
| British Pound Sterling |       | 0.70379            |       | 0.69096               |       |
| Indian Rupee           |       | 51.75983           |       | 49.21259              |       |

 
| ** **             | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| **Average rates:**     |       |                                  |       |   |   |
| British Pound Sterling |       | 0.69606                               |       | 0.50588 |   |
| Indian Rupee           |       | 50.51857                              |       | 39.77975 |   |

 

At thepresent time, we do not hedge our foreign currency exposure or use derivativefinancial instruments that are designed to reduce our long-term exposure toforeign currency exchange risk.  To the extentthat translation and transaction gain and losses become significant, we willconsider various options to reduce this risk.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”), that are designed toprovide reasonable assurance that information required to be disclosed by us in

 

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reports that we file or submit under the Exchange Actis recorded, processed, summarized, and reported within the time periodsspecified in Securities and Exchange Commission rules and forms, and thatsuch information is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure.

 

Our management, includingour Chief Executive Officer and Chief Financial Officer, has evaluated theeffectiveness of our disclosure controls and procedures as of the end of theperiod covered by this Quarterly Report on Form 10-Q.  Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures were effective as of theend of such period.

 

In designing andevaluating our disclosure controls and procedures, management recognized thatdisclosure controls and procedures, no matter how well conceived and operated,can provide only reasonable, not absolute, assurance that the objectives of thedisclosure controls and procedures are met.  Additionally, in designingdisclosure controls and procedures, our management necessarily was required toapply its judgment in evaluating the cost-benefit relationship of possibledisclosure controls and procedures. The design of any disclosure controls andprocedures also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions.

 

During the three monthsended March 31, 2009, there were no changes in our internal controls overfinancial reporting (as defined in Rule 13a-15(f) under the ExchangeAct) or in other factors that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II — OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

During the fourth quarter of 2006, a previous vendor filed a complaintin the Superior Court of New Jersey against us asserting we breached certainprovisions of a license agreement. On April 10, 2009, we settled ourlitigation with this previous vendor and the matter pending in the UnitedStates District Court of New Jersey, was dismissed with prejudice.

 

We are involved in various other legal matters arising in the normalcourse of business.  Losses, includingestimated costs to defend, were recorded for these matters to the extent theywere probable of loss and the amount of loss could be reasonably estimated.

 

**ITEM 1A.  RISK FACTORS**

 

ThisQuarterly Report on Form 10-Q should be read in conjunction with the riskfactors defined in our Annual Report on Form 10-K for the year ended December 31,2008 under “Item 1A. Risk Factors.”

 

**ITEM 2.  UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

 

None

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

None

 

**ITEM 5.  OTHER INFORMATION**

 

                None

 

**ITEM 6.  EXHIBITS**

 

(a)          Exhibits

 

Exhibit 31.1 –Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 –Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 –Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 –Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURE**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Date: May 7, 2009 | /s/ BRIAN R. ERVINE                          |
|------------------------|----------------------------------------------|
|                   | Brian R. Ervine                              |
|                   | Executive Vice President,                    |
|                   | Chief Financial and Administrative Officer,  |
|                   | Treasurer and Assistant Secretary            |
|                   | (Principal Financial and Accounting Officer) |

 

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